Download Facing Pressure to Cut Costs, Fifth Third CEO Plays the Long Game

1Q RESULTS
Facing Pressure to Cut Costs, Fifth Third CEO Plays
the Long Game
By Kristin Broughton April 18, 2016
Fifth Third Bancorp Chief Executive Greg Carmichael has been on
the job for less than six months, but already it's looking like his
honeymoon period may be over.
With Carmichael promising to spend more on technology and
compliance this year, investors are becoming increasingly concerned
that, absent a rise in interest rates, expenses will grow faster than
revenues and further squeeze margins. Several analysts have
recently downgraded their ratings on Fifth Third's shares and even
those holding the line cite rising expenses as the biggest potential
drag on profits.
The $141 billion­asset Fifth Third "did not achieve positive operating
leverage in 2015 and we do not expect it to achieve positive operating leverage in 2016," Barclays analyst Jason
Goldberg wrote in a research note earlier this month previewing the Cincinnati company's first­quarter earnings. "We
believe more needs to be done on the expense front."
Fifth Third is scheduled to release its first­quarter results on Thursday. Analysts are projecting it will say that profits fell
by approximately 30% from a year earlier, to around $270 million, and that higher expenses and credit costs
outweighed lackluster revenue growth.
Several analysts have also reduced their per­share earnings estimates in recent months.
Like many of its regional peers, Fifth Third has struggled to generate revenue from loans. Its net interest margin has
tightened by 10 basis points in the past year, to 2.85%.
Its biggest challenge, though, is reining in expenses.
During the fourth quarter, noninterest expenses grew 5% from a year earlier, to $963 million. Over the past five
months, Fifth Third has added more than 100 new tech employees with six­figure salaries, company said in a recent
press release. It has also invested heavily in cutting edge analytics programs.
Since replacing Kevin Kabat as CEO in November, Carmichael has been saying that Fifth Third needs to invest more
heavily in technology and compliance now in order to boost profits and improve efficiency down the road.
The company plans to spend roughly $60 million this year to digitize its branches, upgrade its loan origination system
and invest in new fraud­detection software. It also plans to invest $75 million on compliance systems and personnel.
Carmichael could not comment for this article because Fifth Third is in a quiet period ahead of its first­quarter results.
But he has said that he expects investments in a slick new mobile app and improved risk­management systems will
start paying off next year.
"They are extremely important investments," Carmichael, a former technology executive, said during a January
conference call. "As we move into 2017, you will see those outcomes."
Analysts agree that the investments are necessary, but they are concerned that Fifth Third's revenues aren't growing
fast enough to pay for them. That could change if the Federal Reserve boosts interest rates this year, but if it doesn't,
core revenue will remain flat, said Peter Winter, an analyst with Sterne Agee CRT.
"The thinking is, in an environment that continues to be challenging on the revenue side, they just have less flexibility
than others," said Winter, who downgraded the stock to "neutral" last week.
Several of Fifth Third's peers — such as U.S. Bancorp in Minneapolis and PNC Financial in Pittsburgh — have
funded big investments in technology by cutting expenses elsewhere.
And Fifth Third, for its part, has also made an effort to trim operating costs. The company recently offered buyouts to
775 of its 18,500 employees. It has also shed about 8%, of its total branch network over the past year.
But the bank is relying heavily on an unconventional source — its ownership stake in Vantiv, the payment processor it
spun off in 2012 — to fund tech upgrades and pad its bottom line. In the fourth quarter, it recognized a gain of nearly
$500 million from a series of stock transactions and the company has said it intends to continue scaling back its
ownership stake. It still holds 35 million shares of Vantiv, and has warrants on an additional 7.8 million, said Chief
Financial Officer Tayfun Tayzun, during a March 9 presentation.
"Our intention is to sell down our position in Vantiv, and we are going to do that in a thoughtful and deliberate manner,"
Carmichael said in January.
Marty Mosby, an analyst with Vining Sparks, said that selling Vantiv shares to help fund its transformation is not a bad
strategy. The risk, of course, is that the bank could wind up selling an appreciating asset to fund investments that don't
pan out as expected.
"The sense of whether they wasted [the Vantiv stake] will be displayed next year," Mosby said.
Mosby is more bullish than other analysts on Fifth Third. He recently downgraded Fifth Third's stock to "market
perform," but only because it is no longer trading at a discount after a recent rally, he said.
Mosby noted that Fifth Third's stock price has increased by about 25% over the past two months, compared to a gain
of about 18% for the KBW Bank index. Year to date, the shares are down about 3%.
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